Thinking Big

By Saki Knafo

On a frigid night in December 2009, the world’s largest cruise ship pulled out of the shipyard in Turku, Finland and glided across the Baltic Sea towards its new home in Florida. At 225,000 tons, the Oasis of the Seas weighed as much as four Titanics. If you could have somehow propped it up on its stern, it would have reached almost all the way to the top of the Empire State Building. Last year, its nearly identical twin sister, the Allure of the Seas (which, due to a ﬂuke, is actually ﬁve centimeters longer than Oasis) made its own inaugural journey. Compared to these two behemoths, the next largest passenger ship in the world, the 150,000-ton Queen Mary 2, suddenly seemed like little more than an oversized ferry.

The Oasis and the Allure are just two of the 22 ships owned by Royal Caribbean Cruises, Ltd. (NYSE: RCL), a $15 billion dollar cruise giant led by CEO and Chairman, Richard D. Fain, WG’72, who has been helping the corporation turn big proﬁts since he started as a director on the Board of Directors in 1979. After a rocky couple of years following the 2008 economic downturn, the tourism industry is ﬁnally seeing some growth. And Royal Caribbean Cruises Ltd., in particular, which comprises Royal Caribbean International, Celebrity Cruises, Azamara Club Cruises, Pullmantur, Croisières de France and 50 percent of TUI Cruises, has been on an upswing, reporting a 2010 fourth-quarter proﬁt of $42.7 million, up from a $3.4 million proﬁt for the same period a year before.

The new ships are a big reason why, because in the cruise industry, at least, size does seem to matter. Besides allowing the company to pack in approximately 6,000 paying passengers per voyage, the fantastic proportions of the Allure and the Oasis mean ever-more entertainments and amenities, including some that have never been seen on a cruise ship before: an “AquaTheater,” where synchronized swimmers and acrobatic divers cavort amid arcing jets of water; a “park”—“Central Park,” actually— with meandering paths, gardens and lampposts; and, believe it or not, real live trees.

Recently, Fain took some time at his Miami office to chat with Wharton Magazine about his strategies for success in the cruise industry, the unique challenges of overseeing a ﬂeet of ﬂoating destinations at sea … and his love of arguing.

Wharton: You recently launched a new ship, the Allure of the Seas. At 1,200 feet from bow to stern, it’s the largest ship in the world. How do you create something like that?

Fain: We started out almost six years ago with the concept of wanting to do something new and different. Oftentimes when you design a new vessel you start with an existing vessel and say, “I want it to be taller or shorter or fatter.” Here we decided to start with a blank sheet of paper and said, “What do we want our guests to do? What activities do we want to offer them?” The name of this project was “Project Genesis.” The idea was to indicate that this was a fresh start in terms of design. We didn’t actually start out intending to build something quite so large. The original concept was to start with, “What is it people want?” You start with blocks of space and say you want all these activities and ask how much space it will require for a particular activity. In addition to offering more internal space for our guests—things like the dining rooms and theaters and the show lounges and all the indoor activities— we wanted to offer more outdoor activities. The whole thesis was to give people more choice. So instead of one large pool deck divided into two we wanted to have a series—one just for families, one just for adults, one just for sports … When we added up all the things we wanted to provide for people to do, it turned out the ship was much bigger than originally expected, as we were also able to provide much more in terms of activities and amenities. And then the ship began to take shape. We brought in world-class architects for what felt like a world-class ship in the making. But probably the most valuable thing was that our people throughout the company really felt that this was ‘their’ vessel. And so probably the biggest factor was the passion. People throughout the organization came up with ideas and concepts, and that’s why we have so many novel ideas on the ship.

W: Can you tell me about one of those novel ideas?

F: I’ll take one, which is the AquaTheater at the stern of the vessel. Someone came and said, ‘What if we open up the stern?’ Technology was also an enabler here. Historically, it’s been very common that you put air conditioners at the core of the ship, and this is always a point of serendipity. One of the things we set out to do was make the ship as environmentally sound as we know how, and one of the ideas that was put forward technologically to make that true was to replace centralized air-conditioner rooms with distributed air-conditioners. So instead of one larger air-conditioning space that sends the heated or cooled air through the ducts throughout the ship you’d have a lot more smaller, individual units, which are more energy efficient because you don’t have the energy loss of transporting the treated air through all that ductwork. But it also freed up the central core in the middle of the ship. That’s usually space that’s hard to use but by opening it up we were able to open it not only for “Central Park” but also for the Boardwalk leading out to the AquaTheater, so that gave us an opportunity to have a large space for people to enjoy an outdoor activity. We already had a pool and sports space so the idea came to do an AquaTheater.

W: Can you give me a sense of the costs involved?

F: The ship costs close to one and a half billion dollars.

W: And that’s just the ship itself, right?

F: Right.

W: It must be incredibly expensive to operate something like this. I mean, I heard that you hired Taylor Swift the other night. How much does it cost to get one of the world’s biggest pop stars to perform for one night?

F: What we want to do is offer our guests an unprecedented level of entertainment and activities so, like you say, we have Taylor Swift, we have a partnership with DreamWorks, we have a Starbucks on board, so there are a lot of other costs associated with that. There are a lot of costs that you wouldn’t even think of. We didn’t want any lines on board- no queues at all. And we actually concluded that if we did have any lines, even if those lines were shorter than they were on comparable ships, people would attribute those lines to the size of the vessel- that’s a common misperception. Just for example, it takes between 40 minutes to an hour-and-a-quarter to go through all the boarding processes to get on board a cruise ship. We set ourselves a goal of being able to do it in 15 minutes from curbside to being on board the ship. That’s simply an unheard of standard. We needed a facility to make that possible and so, working with Port Everglades, they built a terminal- Terminal 18- and the terminal itself and the technology they used to make it effective have cut it down so we are consistently beating the standard by 15 minutes. So there are other costs associated with that. Similarly, when we go to Jamaica there are two very nice ports but we wanted to take it to another level. There was an undeveloped port situated halfway between the other ports in Jamaica, so we’ve worked with the authorities there to make that into a destination. We’ve had to build a pier and an entire infrastructure. Again, these projects are tens of millions of dollars and they all support the ship.

W: These are the costs of running a small city.

F: It has a lot in common with running a small city. We generate our own electricity, make our own water. We have a crew of 2,200 people to make the bread, cook the meals. … So it’s a major city. It’s a major operation. And every Saturday, 6,000 people will disembark and go home with great memories and 6,000 new guests will come and start a vacation of their lifetime and that’s quite a logistical feat.

W: Can you tell me about the ups and downs of the business? I know your earnings were up the last quarter, but it’s obviously been a rocky few years.

F: The last decade is an exciting time to be in any business and the tourism business has had more than its share of interesting challenges. Basically the business model is that we give a vacation that people really enjoy at a reasonable price. So the all-in costs of taking a cruise with us is actually less than the costs for taking a comparable vacation on land or lower, but the satisfaction is higher—in surveys people say that they prefer our cruises. If you go on a tour package or go to a resort or go to Disney World, and if you look at the all-in costs—people often just look at the airfare—it’s just as expensive. If you look at a cruise, it includes your transportation between countries, within countries, between islands, it includes your entertainment, and it includes your food. However, if you look at land vacations you’re paying for everything separately. The business is doing well but we had two major hits over the past decade. The ﬁrst of course was 9/11, which was pretty devastating across the board in the tourism industry. But I think while we suffered the fact that we didn’t suffer so badly shows how resilient the industry is. And then of course right when we were coming into our own after 9/11 we had the Lehman Brothers collapse and everything associated with that. That was a big hit for us. We’re recovering from that and although we’re still not back to our previous yields before the collapse we’re looking at proﬁtability that will be the best in our company’s history.

W: How do you account for that?

F: I think it’s the strength of the business model. Our brands are doing well in spite of the economic situation. We’ve worked hard powerful drivers. Because of their amenities they generate higher revenues. When you offer people all the beauty and the choices that we do people tend to pay more for that. There’s an economy of scale for having a larger vessel, so the fuel costs of a larger vessel—and I’ve already talked about the environmental efforts we’ve made—a larger vessel is more energy efficient. It also reduces our energy costs. You have the same navigational team as you would on a small ship. If you’re baking 50 percent more loaves of bread it doesn’t cost 50 percent more to do that.

W: What do you mean by your brands doing well?

F: We offer six brands and the key to any consumer business is to have a brand people recognize and trust. When you’re considering a vacation you’re thinking, I can do that with this company or that company, and if one company has a reputation for delivering consistent quality at a reasonable price, that’s your brand. We’ve worked hard to make sure that each of our brands is at the top of the competitive set.

W: How do you do that?

F: I think the most important thing is the crew. For us, historically, the crew has been the thing that most people enjoy the most. They produce a wonderful vacation with an enthusiasm that I am in awe of, so people come off of the cruise and say they had the time of their life.

W: What is the competition like in the cruise space?

F: It’s a highly competitive industry. Tourism is something that people care intensely about. People take vacations because their time is so valuable and they value their time and experience highly, so they’re careful about it. I’m pleased to say the industry has not succumbed to the problems that some other industries have—to competing primarily on price and to homogenizing the product. So the different cruise brands are well understood. Each has its own characteristics and appeals to its own set of customers. And we compete heavily on the attributes, activities and amenities that we offer. Obviously, in addition, pricing is an important component to that, but I’m happy to say it isn’t the primary component.

W: How does Royal Caribbean position itself?

F: There are six different brands, based on nationality, based on age and income. We position ourselves based on pyschographics, so for example the Royal Caribbean International brand tends to be for more active cruisers, oftentimes with families. Celebrity Cruises targets the affluent vacationer, the wine enthusiast, the foodies, while Azamara Cruises gives destination immersions, staying overnight in most ports. The TUI Cruises brand appeals almost exclusively to German customers. Pullmantur is a three-star brand operating mostly for Spanish guests and South American guests, and if you go on Pullmantur you have to like paella and the ﬁrst dinner seating starts at midnight. If you went on Pullmantur ships out of Brazil I think you can expect to be dancing until quite late at night. If you’re on Croisières de France you’d better speak French and you’d better like French cooking. So I think the important thing is we try to appeal to our different market segments. Obviously, we’ve grown and we’ve added new brands as we’ve expanded, so we’ve grown internally—generating growth by building and adding new ships. And we’ve grown by building and buying new brands. Azamara Club Cruises and TUI Cruises are two of the newer brands within in our family, but the overall Royal brand is celebrating its 40th anniversary.

W: How else has the company changed over the years?

F: One of the things that we’ve been very pleased about is the increased concentration on using technology and innovation to make our cruises more interesting and better for the guests. So we’ve made it easier to book the cruise and offer experiences that you couldn’t otherwise get, but also, at the same time we’ve reduced the ages. The average age of a Royal Caribbean International cruise guest last year was 44 years old. On average that’s a 10-year drop from where it was 10 years ago. That’s a huge change. Good marketing has helped communicate a brand that has a clear personality and experiences that our guests want.

W: Why are you proud of lowering the age?

F: I think we’re proud of it because we do it well. I think you can appeal to any market segment. What’s important is that, you be true to that marketing vision. We set out to be at the top end of our competitive sets in terms of quality and pricing—we actually set out to appeal to a slightly different demographic—and, yes, they tend to be younger.

W: What are the metrics you use to measure success, beside market share?

F: In the end, the measure of success is proﬁtability. And we use a lot of other metrics in making sure that we’re addressing the right market and serving the right market properly. That includes guest satisfaction, guest relations with the brand which includes employee involvement. We’re also very focused on “things that go bump in the night”—safety, security, environmental protection, etc. All those things hopefully come together and produce good ﬁnancial results and that’s what they’ve seen. We measure guest satisfaction, mostly through surveys, but also through repeat rates, etc. Proﬁtability is obvious. For safety, security and environment you tend to measure actual incidences and their severity.

W: Change of pace here. You did your undergraduate work at Berkeley. How did you end up at Wharton?

F: I actually went relatively quickly from undergraduate to graduate. In between I did a stint at Wells Fargo Bank—operations research—and then I joined the National Guard and did basic training. And then came to Wharton.

W: Why?

F: There had never been a doubt in my mind that I wanted my career in business and I’d heard so much about Wharton. My undergraduate work was in economics, which was very ﬁne on the theoretical basics and I’m glad I had that, but there was very little practical application of anything I studied. I felt from an early stage that business had a great deal of ability to accomplish things, and you had a clear understanding of what you were trying to accomplish. I also felt it was a meritocracy, and so it evolved over time.

W: Looking back on your days at Wharton, do any classes stand out as particularly memorable or valuable for you?

F: I think the real value I got from it was not so much the speciﬁc learnings, though I do remember being forced to learn calculus and hating every moment of it, but I think it did teach me to be constantly questioning. I think one of the things that is consistent between my experience at Wharton and the culture here at Royal Caribbean is a constant striving for improvement. Our mantra here is “continuous improvement.” I think one of the things I liked at Wharton was that there was constant questioning, and here I like the fact that people are constantly striving to outdo themselves.

W: How do you encourage that?

F: I wish I knew. I think it starts with people who are passionate about what they do. I think you have to enjoy what you do to do it well. Again, when I was at Wharton people really seemed to care about trying to do better. And I think here we’ve been fortunate enough to have very good people whose biggest critics are themselves. So I think it starts with the right people and I was fortunate enough to ﬁnd here a culture that welcomes debate. I love to argue and it’s a wonderful thing. Things come out of the woodwork when you argue about them.

W: Like what?

F: On one of our earlier ships we had a space we were looking to add more activity to, and we asked a team to go out and bring us some possible things we could do with that space. And they came back with a set of four choices. I looked at them and all four were really silly and I thought all four were terrible. We argued about it at length but they really pressed for one idea, which was a rock climbing wall. And I really thought that was a dumb idea. But there were very strong arguments for it. They came and brought evidence of the growth of interest in rock climbing throughout the country. They showed how it could be done. Their arguments forced them to reﬁne both their idea and how it would work. We did put it on the ship. It turned out to be amazingly popular. We now have rock climbing walls on all of our ships, and now as we look back I’m convinced it was one of the better ideas we’ve ever had.

W: How do you encourage argument without dismissing ideas before they have a chance to evolve, or creating an environment where people feel discouraged?

F: I think arguing is one of the best ways to reﬁne ideas. But I don’t think many people with open minds leave an argument without some change in their own view. The purpose of argument is often just to convince, but I think the result is that you learn something about your own position as well as someone else’s position when you argue it through. Also, if you know you’re going to argue something, you tend to be more careful in your calculations. You don’t just assume things. You do the research to make sure that your intuitive feeling is supported by empirical evidence. Most of us here—and I’m lucky enough to work among people who enjoy that process—ﬁnd it invigorating. And I would say probably most of the time the argument serves to reconﬁrm one’s starting positions. But oftentimes the argumentation ends up as an eye-opening experience, and we all say, “Wow, I never thought about it in those terms and now I get to think about it in a different perspective.” There’s no question it’s more demanding, but most of the people enjoy that challenge.